Illusion cops a beating from reality Email Print Normal font Large font Ross Gittins March 21, 2007 Advertisement AdvertisementTimes are getting tougher for John Howard - and I'm not referring to a few embarrassing resignations from his ministry. No, it's the economy. It's growing so strongly the Reserve Bank is contemplating raising interest rates again. And that brings us to housing. The factor that contributed so much to Howard's victories in elections past may start costing him votes. We're at the point of experiencing the downside of the housing boom. Many home owners have been most gratified to see the value of their home at least double over the Howard Government's 11-year term. But economic theory tells us the feeling of increased wealth people enjoy is an illusion. And we've reached a point in the housing cycle where they'll find that easier to accept. Think of it this way: the inhabitants of an island have roughly the same stock of homes they had before, but now they've decided those homes are worth twice as much as they used to be. How does that leave those inhabitants better off? When you look at it from the viewpoint of the community as a whole, you see we're not better off. Why not? Because you've got to live somewhere. Were you to sell your home to realise the increase in its value, you'd either have to buy another place to live in or rent another place. The house you move to will also have doubled in price. Alternatively, rents will have increased to reflect the higher value of the place you're renting. But if the notion that housing booms leave home owners better off is an illusion, why do so few of us see through it? Partly because it's pretty much only people with economic training who can look at things from the "macro" perspective of the community as a whole. Most of us only ever view situations from our own individual, "micro" perspective. And from the perspective of the individual, some people win from a property boom while others lose. (At the community level, these wins and loses essentially cancel out.) The outright winners are people who own homes before the boom starts, but are then able to "trade down" by moving to a smaller, cheaper home or to a cheaper city. And, of course, those who die. The outright losers are people who didn't own a home before prices doubled. These include renters, and also young people who may not yet have left home - or may not yet be born - but will wish to be homeowners in the future. But there's also a fair bit of self-deception. Remember that the primary reason for the boom was the halving of mortgage interest rates, which roughly doubled the amount people could afford to borrow. It was because so many people sought to "trade up" to a bigger or better home at pretty much the same time, with the supply of houses little changed, that we succeeded in doubling the price of homes. (An economist would say this exercise caused the benefit from the fall in interest rates to be "capitalised" into the price of homes.) The trick is that, although the price of the home a person was selling may have shot up, so did the price of the home they were buying. And since the home they were moving to was always the more expensive, its price probably rose by more - in dollar terms - than the price of the home they were selling. In which case, they're likely to have acquired a bigger mortgage. So it's hard to see why they imagine they're so much better off. A great many home owners would find themselves in this position. Now the boom is over and house prices are pretty flat - and falling in parts of western Sydney - the drawbacks are much easier to see. The first group with a hangover are those with big mortgages, who can't be too pleased to hear talk of another rise in interest rates, perhaps as soon as in a fortnight's time. Included among those fearing another rate rise are all those people with negatively geared property investments. Without the hope of continued strong growth in house prices, their resolve to stick with their investments will be sorely tested. Higher rates add to their monthly out-of-pocket payments (which are only partially subsidised by their fellow taxpayers). What started as a way to get rich quick has been transformed into a way to bleed slowly. More may decide to cut their losses and sell. It's likely that a lot of the mortgagee sales we're hearing about are of investment properties. Where investors hang on, it's likely they'll be determined to take advantage of the increased demand for rental accommodation relative to supply and put their rents up. Which means life is getting tougher for renters. Most don't know it but they've had an easy ride as investors piled into the market with their eyes fixed on unending capital gains and with rental income a secondary concern. Not any more. The usual way of escape from renting is home ownership, but for many that route's been blocked by the sky-high price of homes, made all the more unaffordable by steadily rising interest rates. And this brings us back to all those older people still congratulating themselves over the doubled value of their homes. It's easier now to see that the rise in house prices constitutes an inter-generational transfer of wealth from the young and unborn to the older generation of baby boomers and others. Ah, the sting in the tail. If you don't have offspring or grandchildren - or you do, but you don't care - you're laughing. But most of us do have offspring and we do care - deeply - about their future welfare and their ability to enjoy the Great Australian Dream of home ownership. As established home owners realise the extent to which their seeming good fortune has come at the expense of their descendants - and what this means for the boost those descendants will need to leap the barrier to home ownership - their perception of great housing wealth will be revealed as an illusion.